Magazine

Slipping Past The SEC

June 18, 2006

Even after the pullbacks across financial markets during the past several weeks, money still comes easily to corporations. Perhaps too easily. Their borrowing costs, as reflected in the amount of interest they must pay bond buyers above the risk-free U.S. Treasury bond rate, hover near 10-year lows. And yields on the riskiest "junk" bonds are running about 7.8%, just 2.8 percentage points more than Treasuries. That gap reached 8 percentage points as recently as 2002, according to the KDP High Yield Index.

The easy terms go beyond low interest rates. Corporations are also being allowed to forgo registration with the Securities & Exchange Commission, avoiding the Sarbanes-Oxley Act's requirements for proof of effective financial controls. That's because registration can be optional when securities are sold only to institutional investors. And institutions are letting some bond issuers who simply don't want to comply with SarbOx off the hook.

Until recently it was rare that investors would buy bonds unless companies promised to submit to SEC standards. But this year companies have raised more than $4 billion without committing to SEC registration. In March, HRP Myrtle Beach Operations LLC borrowed $155 million to build a new Hard Rock Cafe theme park in Myrtle Beach, S.C. In April the Carlyle Group raised $225 million toward a $1 billion leveraged buyout of health-care provider MultiPlan Inc. Bain Capital raised $315 million with the same leeway, selling eight-year notes to buy Nutro Products Inc., a pet food maker.

"We really don't like it, but we need bonds," says John Addeo, a portfolio manager at MFS Investment Management. "Our market is funding riskier deals, in terms of their leverage and flexibility [for borrowers]."

The higher risk-taking isn't so much a sign of extra confidence in the borrowing companies as it is a consequence of competing lenders offering so-called leveraged loans, says Kingman Penniman, president of KDP Investment Advisors Inc. Those loans, which also aren't registered with the SEC, traditionally were held by banks. Now some are being funded with new money from hedge funds and overseas investors through pools that purport to reduce risk through diversification. The competition is taking a toll on bond investors. "At these [yields] you want to be getting more protection, but you're getting less," says Penniman.

To borrowers, that's a blessing. "It lets us remain a private company without all of the encumbrances of Sarbanes-Oxley," says Steven Goodwin, CEO of HRP Myrtle Beach. Gordon H. Woodward, a principal at Kohlberg & Co., which used the tactic in its April buyout of Packaging Dynamics Corp., says not filing financials avoids showing competitors restructuring plans.

But that doesn't satisfy some pros. Martin S. Fridson, president of research firm FridsonVision, says requiring people to register for access impedes the free flow of information that makes markets work. Worse, he says, it could tempt borrowers to invent ways to bar analysts they don't like.

Shifts in power to issuers come near market tops, says Fridson. Private financial reporting may fly now, but companies are likely to find borrowing terms much stricter when the market cools off.